No debt deal could have serious consequences

Saturday, February 02, 2013

The following pithy quote was taken from one of the protestors who last weekend turned up for the 100th Ballyhea march against bank debt and bailing out the bondholders: “We need to get this European monster off our backs.”

So far, this opinion represents a minority view in this country. Most people are still well disposed towards the EU. But that could change quite soon if there is no deal forthcoming on the bank debt. If this were to happen it could have very far-reaching consequences.

The Government suffered a setback last week when its preferred solution to restructuring the €30bn in promissory notes was rejected by the ECB. It is believed the Frankfurt-based institution wants the Government to use the ESM to wrap the promissory notes into a long-dated bond.

Legal obstacles are in the way of finding a solution through the ECB. But there will be many political hurdles if the Government goes the ESM route. Public mood is hardening in Germany, Finland and the Netherlands against any sort of fiscal transfers.

The Government says it is still confident of a bank deal before the next €3.1bn promissory note repayment is due in March. If it doesn’t then the many shortcomings of the eurozone are likely to be cruelly exposed.

Without a deal, Irish debt-to-GDP is forecast to peak at 121%. This will keep the economy at near recessionary levels for years to come. Unemployment will remain high. The mortgage arrears and personal debt crisis will persist — despite the personal insolvency legislation.

Banks will struggle to repair their balance sheets, which means they will not be transmitting credit to the wider economy. A vicious debt deflationary cycle could take hold. This scenario is by no means certain, but is a real possibility.

The Government has staked its reputation on securing a bank debt deal. If none is forthcoming, then its satisfaction ratings will plummet.

The eurozone is moving towards closer political and fiscal integration. This will require a substantial treaty change. Rising anti-EU sentiment would almost certainly see any future plebiscite rejected. What would this mean for Ireland’s membership of the single currency?

On the other hand, if a bank debt deal, which would put Ireland on a sustainable path, is agreed, then a virtuous circle could take hold. A recovery would still be slow but the economy would at least be moving in the right direction.

Private sector investment would return which would benefit indigenous companies and boost employment levels. The electorate is more likely to take the view that the country is better off inside the euro. At the very least, the Government would be able to put a convincing case to the people ahead of the next treaty referendum.

Ireland has so far shouldered a hugely disproportionate burden of the debts racked up by the banking implosion. The cause of the crisis was deep flaws in the architecture of the eurozone. Reckless lending by German banks in particular were just as much to blame as the reckless borrowing by Irish financial institutions.

The next few weeks will be crucial not just for this country — it will also be extremely important for the future of the euro.

If the creditor countries insist that what is needed is more austerity, then public opinion will inevitably turn. The level of untapped anger could mutate into something very hard to control. Brussels, Berlin, Frankfurt etc really need to take note.